CORPORATE INSURANCE
BY GLENN STEPHENS
Donating Life Insurance What are the opportunities and pitfalls?
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ncome tax incentives have made the donation of life insurance policies an attractive alternative to surrendering policies that are no longer required for their original purpose. Let’s consider the advantages of policy donations in addition to potential income tax and regulatory pitfalls of which charities and prospective donors should be aware. Where a life insurance policy is donated to charity, the amount of the donation for receipting purposes will generally be equal to the policy’s fair market value. This would typically be determined by an independent actuary, who would consider a variety of factors, including the type of policy, its replacement value, and the life insured’s state of health. In most cases, a policy’s fair market value will exceed the amount that the policy owner would be entitled to receive on a surrender of the policy, and potentially provide the policy owner with significant incentive to donate rather than simply terminate the policy. A donation is a disposition for income tax purposes, but is taxable only to the extent that the policy’s cash surrender value exceeds its adjusted cost basis (ACB). Any tax cost will generally be more than offset by the charitable tax credit. However, there are some income tax and regulatory issues to consider. From an income tax perspective, some rules reduce the amount of a gift where the donor has owned the gifted property (including life insurance) for less than three years. They also apply where a gifted policy has been owned for less than 10 years, if one of the main reasons for acquiring the policy was to make a gift. The general effect of these rules will be to limit the amount of the donation to the policy’s ACB, which in the case of older policies, will be significantly less than fair market value.
In this regard, a question arises when a term policy is converted to a permanent policy then donated to charity. Does this constitute an acquisition of a new policy for the purposes of the three- and 10-year rules described earlier? If so, the value of the converted policy for donation purposes would be limited to its ACB. It is unclear how the Canada Revenue Agency would view the donation of a recently converted permanent policy, and the Conference for Advanced Life Underwriting (CALU) is seeking a technical interpretation. Presumably, this issue could be avoided by first gifting the term policy to the charity, with the charity subsequently converting the policy into a permanent policy. A cautious approach is recommended, and interested clients should consult qualified tax and actuarial advisors. Regulatory concerns also need to be considered, in particular the “anti-trafficking” rules that exist in the Insurance Act of most provinces as a means of prohibiting the commercial trading of life insurance policies. While the donation of an insurance policy to charity would not normally be considered “trafficking,” it was nonetheless characterized as such by the B.C. Financial Institutions Commission in a June 2019 letter to a charitable organization that was actively soliciting the donation of insurance policies. The Commission stated that the activities of the charity were in breach of the B.C. anti-trafficking rules and that it should cease the solicitation of policy donations from B.C. residents. The concerns raised by this letter were eased when the Commission issued a follow-up letter in May 2020, in which it stated that the solicitation of insurance policy donations by “bona fide” charities, and the donation of policies to such charities, is not generally prohibited.
Primarily in response to these regulatory concerns, the Canadian Association of Gift Planners (CAGP) has developed guidelines regarding the charitable donation of life insurance policies. A complementary set of guidelines has been created for charities, advisors, donors, and life insurers. One of the key objectives of these guidelines is to ensure that policy transfers to charities are not used as a means of circumventing provincial anti-trafficking rules. Many other issues are dealt with in these guidelines, which are readily accessible on the CAGP website. While income tax and regulatory concerns do exist, significant incentives remain for the donation of in-force insurance policies. Advisors can play a key role in alerting clients to these advantages as well as any potential pitfalls, and in assisting charities in assessing the policies being put forward as potential gifts. In particular, advisors can help charities understand the rights and obligations within the insurance contracts, especially those involving future premium payments that may have to be funded by the charity. A final reminder: the above discussion focuses on the transfer of policy ownership to charity, and there are many other ways outside the scope of this article that life insurance can benefit charitable organizations. For example, by retaining policy ownership and designating a charity as beneficiary, the policy owner will not receive a current tax credit. However, the proceeds themselves will be treated as a charitable gift when paid to the charity, resulting in significant income tax benefits to the donor’s estate. GLENN STEPHENS, LLB, TEP, FEA, is the vice-president, planning services at PPI Advisory and can be reached at gstephens@ppi.ca.
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